The Obama administration’s 2012 budget proposes eliminating a key source of financing for rural multifamily developers.

The USDA’s Sec. 538 program—which guarantees loans for new construction, rehabilitation, and permanent financing in rural areas—is on the chopping block. The program is critical for those building in areas with populations of less than 20,000, where financing is much more difficult to come by. Even the Federal Housing Administration (FHA) has little appetite for such deals, especially since most Sec. 538 deals are so small (averaging about $1.2 million), and off the beaten path.

Funding for the program has been around $129 million annually for the past four years, and it’s increasingly being used for affordable housing properties—a priority of the Obama administration. Last year, there were 98 Sec. 538 loans closed, and of those, 88 had low-income housing tax credits.

“Yet, the administration has chosen basically to abandon the program as time goes on,” says Carl Wagner, a chief architect of the Sec. 538 program when he was in charge of the USDA’s multifamily processing division in the mid-1990s.

As justification for cutting the program, the administration pointed to a very high Sec. 538 default rate of 11.7 percent. But many in the industry can’t understand where those numbers came from. 

Last December, the Council for Affordable and Rural Housing (CARH) submitted a Freedom of Information Act request to try and figure out how the government arrived at that 11.7 percent figure. Two months later, CARH was still waiting to hear. So CARH sent a letter to the chairman and ranking member of the Senate’s Appropriation’s subcommittee on rural development in mid-February. As of press time, they were still waiting on a response.

In the meantime, Wagner joined forces with CARH to research the matter on their own. They surveyed every lending institution that ever made a 538 loan—439 loans all told—and found just nine properties that went into default since the program began in 1996. That would make a default rate of just 3.23 percent over the course of 15 years.

The focus now for Wagner and CARH is on making the program budget-neutral by instituting a 35 basis points fee on all new Sec. 538 loans. “You can simply build a user fee into the program, which will generate enough funding so that it offsets what Congress would have to allocate to operate the program,” says Wagner, now a senior vice president with Columbus, Ohio-based Lancaster Pollard. “It’s relatively simple, concise, and should be nonpartisan.”

Oddly enough, the program used to charge this fee up until 2008. When Congress eliminated the interest credit assistance part of the Sec. 538 program, it accidentally also eliminated the fees for the program. “We’re just trying to bring it back,” Wagner says.

The concern now for Wagner and CARH is that Sec. 538 is a small program, and Congress is much more interested in using an ax, and not a scalpel, to rein in spending. While CARH’s efforts to educate lawmakers as to the importance of the program continue, its success or failure won’t be known until the budget is a done deal. “When a continuing resolution for 2011 or a budget is passed, it will either have the language in it that puts the fee back in, or it won’t,” Wagner says. “That’s the only way we’re going to know for sure.”